Thursday, September 30, 2010

The Austrian school of economics has historically been a strong opponent of Keynesianism. Keynes himself opposed the economics of Friedrich August von Hayek, a major thinker of the Austrian school. I advocate Post Keynesian economics on this blog, and naturally think that Austrian economics has major flaws. Nevertheless, I think Keynesians should be familiar with their Austrian opponents and the theories of Austrian economics. There are of course different strands of Austrian economics, e.g., the tradition of Mises, Hayek, Murray Rothbard, the radical subjectivist thought of Ludwig Lachmann, and the more recent academic theory of Gerald O’Driscoll and Mario Rizzo.

Some years ago Gerald P. O’Driscoll and Mario J. Rizzo made some favourable comments about Post Keynesian economics. In their book The Economics of Time and Ignorance (Oxford, UK, 1985, p. 9), O’Driscoll and Rizzo argued that

“[i]t is evident that there is much more common ground between post-Keynesian subjectivism and Austrian subjectivism …. the possibilities for mutually advantageous interchange seem significant.”

In response to this, Paul Davidson criticised Austrian economics in his classic articles “The Economics of Ignorance or Ignorance of Economics?,” Critical Review (1989) 3.3/4: 467–487, and “Austrians and Post Keynesians on Economic Reality: Rejoinder to Critics,” Critical Review 7.2/3 (1993): 423–444. Steve Keen has also provided a critique of Austrian economics in his outstanding book Debunking Economics: The Naked Emperor of the Social Sciences (London and New York, 2001).

Thursday, September 23, 2010

There are a number of academics and commentators who appear to believe that Keynes was not actually a Keynesian, whatever that assertion is supposed to mean.

However, I don’t wish to examine this specific question in detail. In the sense that Keynes, for a good part of his life, was a monetary economist, it might be said that “Keynes was not a Keynesian.”

But in truth such an idea is fatuous. By the same type of reasoning, we might as well say that Newton was not really a “Newtonian,” because he only published his scientific classic Philosophiae Naturalis Principia Mathematica in 1687 when he was 45 years old and had lived for more than half of his lifespan of 84 years. Clearly, we have to take account of the mature and considered opinions of someone to determine how to characterise their thought in an historical sense. It can also be noted that Keynes was certainly not an advocate of the neoclassical synthesis Keynesianism that became mainstream macroeconomics after the Second World War. Keynes was himself far closer to the modern Post Keynesian school of thought on many issues.

My purpose in this post is to ask: what would Keynes have thought of neochartalism/modern monetary theory (MMT)?

It must be emphasised that modern monetary theory (MMT) is not simply classical Keynesianism or neoclassical synthesis Keynesianism, where the budget is balanced over the business cycle. MMT is far more radical than classical Keynesian economics.

MMT developed from Abba Lerner’s theory of functional finance, as well as G. F. Knapp’s theory of chartalism, as propounded in his book The State Theory of Money. I consider modern monetary theory (MMT) to be a branch of Post Keynesian economics (others might disagree). Neochartalism/MMT provides the best theory and empirically-sound explanation of how our modern fiat monetary systems actually work. MMT tells us that the government is the monopoly issuer of its own currency. Hence the government is not revenue-constrained. Taxes and bond issues do not finance government spending. No entity with the power to create and destroy money at will requires anyone to “fund” its spending. Having said this, one must immediately say that, even though deficits are not “financially” constrained in the normal sense, they do face real constraints in the inflation rate, exchange rate, available resources, capacity utilization, labour available (= unemployment level), and external balance. But these constraints are very different from the fictional “financial” constraints imposed on governments in the modern world, where monetising budget deficits (itself an inaccurate and redundant expression and a relic of gold standard thinking) is hysterically denounced from virtually all quarters. MMT says that governments should have the power to create money to “fund” a budget deficit in whole or in part, without the need for issuing bonds. The purpose of government deficits and spending is to manage the economy and create full employment and stabilise demand. Whether a budget deficit is necessary or not depends not on the state of the business cycle, but on other factors such as maintaining full employment and ensuring that the nation can reach its potential GDP (see Bill Mitchell, “Deficit spending 101 – Part 1,” 21 February 21, 2009).

According to MMT and even in Abba Lerner's earlier theory of functional finance, it is not even necessary to balance the budget over the course of the business cycle, since the government can exercise its powers of money creation to ensure that the stock of government debt and the interest on that debt does not reach problematic levels. In the quite memorable words of L. Randall Wray, “the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion” (see L. Randall Wray, “Paul Samuelson on Deficit Myths, Time to Drop that Old-Time Religion,” April 30, 2010). This of course does not mean that the government should let its debt rise to too high a level or that it should run deficits during periods of full capacity utilization and full employment. On the contrary, in these periods, when inflationary pressures occur, the government should run a budget surplus and destroy money, a process which can contract demand and cool the economy down.

One could also say that there will probably always be a need for government bonds as risk-free financial assets, so that retirees or people saving for retirement do not have to gamble their money on casino-like financial markets and asset price speculation. Government bonds can thus be considered a type of welfare instrument, so that completely eliminating the stock of such bonds would just hurt savers looking for safe financial assets.

Abba Lerner described the fundamental ideas of functional finance in an article called “Functional Finance and the Federal Debt” (Social Research 10 [1943]: 38–51).

Now we come to the main question: what did John Maynard Keynes think of Abba Lerner’s functional finance theory, the early form of MMT?

My discussion is based on the fundamental article by David Colander on this subject (“Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4 [1984]: 1572–1575).

In 1943, Keynes gave a lecture at the Federal Reserve, and apparently disagreed with Lerner’s post-war policy recommendation of classic Keynesian deficit spending to induce enough spending in the private economy. Later, according to Abba Lerner, Keynes withdrew this opposition (Colander 1984: 1572–3).

There is some evidence that Keynes might eventually have agreed with Abba Lerner on functional finance (if of course Keynes properly understood the argument of Lerner’s 1943 article), and that he may have been sympathetic to what later became Modern Monetary Theory.

I quote from the article of David Colander:

“As Lerner said …, Keynes retracted his characterization of Lerner’s ideas as ‘humbug.’ According to Lerner, ‘in reading … [The Economics of Control] later, at leisure, … [Keynes] found the logic less escapable and the resistances more obvious’ … Keynes admitted to being at least a closet Lernerian in a letter to Lerner (September 1944) congratulating him on The Economics of Control. Keynes wrote:

I have marked with particular satisfaction and profit three pairs of chapters-chap. 20 and 21, chap. 24 and 25 [where Lerner had discussed functional finance], chap. 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going-probably impossible. I shall have to temper its austerity where I can. I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!

It was not only in this letter that Keynes retracted his initial remarks about Functional Finance. In 1945, when Keynes again visited the United States, he repeated his praise of Lerner at another Federal Reserve Seminar. In this meeting Keynes spoke in glowing terms of Lerner’s contribution and ‘without any provocation, he held forth a panegyric on Functional Finance’ … Later that evening, at a dinner Alvin Hansen had arranged for Keynes, Lerner and Keynes had another exchange which is also worth noting. Lerner approached Keynes and asked: ‘Mr. Keynes, why don’t we forget all this business of fiscal policy, public debt and all those things, and have some printing presses.’ Keynes, after looking around the room to see that no newspaper reporters could hear, replied: ‘It’s the art of statesmanship to tell lies but they must be plausible lies.’”

Was Lerner by his “printing press” remark suggesting that the government should create its own money to fund deficit spending (in whole or part, as required), a principle that he certainly advocated in Lerner 1943: 40–41?

And what did Keynes mean by his remark: “It’s the art of statesmanship to tell lies but they must be plausible lies.” Was Keynes saying that the idea of having a central bank create money for government spending was too radical an idea for the public and contemporary politicians, and that the government could not do it in practice because it was too unconventional? And was Keynes even hinting at his own essential agreement with Lerner on the issue of functional finance?

And that raises the question: if Keynes were alive today would he have supported MMT?

Wednesday, September 15, 2010

Ireland’s GDP growth of 2.66% in Q1 2010 needs some analysis. Technically, Ireland is out of recession, but does this prove that austerity is the path to robust growth?

It has to be stressed that one really needs to look at Irish GNP as well as GDP to get the whole picture about Ireland. GNP strips out the part of GDP that includes factor flows to foreigners, and in particular profit repatriation to foreigners. In other words, GNP gives a measure of the value of goods and services produced in a country that is earned by domestic institutions and individuals, and can be expressed in this way:

GNP = GDP + net foreign factor income.

Factor income is equal to the earnings on foreign investments minus payments made to foreign investors, and is a component of the current account.(1)

Although GNP and GDP are calculated differently and are different measures of national income, for many countries GDP tends to be very similar to GNP, with no significant difference (see “Output Volatility: GDP v. GNP”). However, there is a set of countries where this is not the case, and Ireland is in that set (for the figures on Irish GDP versus GNP, see here).

On the basis of the GNP figures, Ireland is still in recession. Moreover, since one definition of a depression is a fall in the value of output exceeding 10%, it is probably more accurate to say that in 2009 Ireland entered a depression both in terms of its GDP decline (10.1%) and its GNP contraction (14.1%) since 2008 (for figures, see here).

Irish GDP growth in Q1 2010 was mainly driven by exports, but the problem is that most of Ireland’s internationally-oriented export sector is foreign-owned.

It can also be noted that Ireland – just like Germany and other Eurozone nations – has benefited from the weaker Euro in export markets. But this surge in exports partly caused by Euro depreciation has nothing to do with Ireland’s austerity.

As Bill Mitchell has argued:

There are over 600 American companies with major operations in Ireland. As the Euro depreciates Ireland’s exports (pharmaceuticals, software, food and services) are increasingly cheaper and more attractive to its two major trading partners Britain and the US.

But both the UK and the US have had Keynesian stimulus, so even here the demand for Irish exports must have been influenced by, and related to, the Keynesian stimulus measures taken in both the US and the UK to increase aggregate demand. If the US and the UK had both pursued brutal austerity, would their imports of Irish goods have been significantly reduced? Undoubtedly, they would have been, and Ireland’s growth in Q1 would no doubt have suffered as well.

Yet again we can see that export-led growth in Ireland, as in the case of Germany in Q2 2010, has been influenced by global Keynesianism.

The truth about Ireland is that its domestic economy continues to decline, and that the profits earned by its foreign-owned export sector are – as you would expect – flowing to foreigners and not increasing domestic Irish GNP or per capita GNP. The most devastating proof of how misleading the GDP figures are is that Ireland’s unemployment rate continues to rise.

Since unemployment in Ireland was 4.3% in 2007 when the recession struck, the Irish unemployment rate has soared by a shocking 220.93% since 2007 (for figures, see here).

Even if we take the worst estimates of US unemployment as calculated by John Williams of Shadowstats, the US unemployment rate rose from about 12% in 2007 to about 22% today, an increase of about 83.33% (for the figures, see here), which, while certainly very bad indeed, is nowhere near as bad as Ireland in terms of the percentage increase.

One has to ask: if austerity Irish-style is the path to recovery, then where are the new jobs and employment? Where is the growth in GNP? Where is the domestic growth?

Sunday, September 12, 2010

First, let me offer a caveat: this post contains some speculative musings of mine on the future of manufacturing. No doubt various criticisms of it could be made.

Countries like the US and the UK are badly in need of trade and industrial policies to rebuild manufacturing. Very large trade deficits are potentially unsustainable. Such deficits often make a country dependent on foreign investment for the capital account surpluses needed to pay for current account deficits.

The crucial factor now, however, is that technology must be used to increase manufacturing productivity and cut costs.

If we want to decrease the trade deficits of the US or the UK, I would suggest an industrial policy to domestically manufacture things imported from China and East Asia.

Strong use of automation and technology to increase productivity and to lower price is necessary. This process can be made faster and more efficient through public R&D programs, and state transfer of new technology to domestic manufacturers.

The US federal government needs to take up these ideas and implement this sort of policy at a federal level – which would make it more effective.

Moreover, the article cited above points out that from 1995 to 2002 the global labour force actually lost 22 million manufacturing jobs because of labour-reducing productivity gains through automation and robotics.

I would argue that it is extremely likely that the 21st century will see manufacturing employment as a percentage of the world labour force decline to a level as low as agricultural employment in most developed nations (2 or 3%).

Will this be a bad thing? Not necessarily. If output massively increases, prices are much lower and Western current account deficits fall or go into surplus, this will be a very good thing, and we will have an abundance of cheap goods.

But we will have to face the fact that, because of automation and technology, employment in tradable goods and services in many countries will probably fall dramatically. Our employment future will probably be mainly in services, education, and most probably in government-sector jobs or employment programs funded by government. There will probably be a great reduction in the hours that people need to work as well.

No doubt additional jobs will be created in new private industries as well, but government can step in and provide employment for those who are unemployed. It might well be that much of the government-funded labour force will be in education (e.g., universities), research or other services. A much greater labour force working in basic sciences and applied R&D in physics, chemistry, geology, biology, genetics, engineering and medicine would mean a much more rapid advancement of science and technology too – a virtuous circle.

In other words, in the face of massive productivity and output gains and cost reductions in many goods and services through technology, the government must use policies for full employment to maintain demand for such goods. The point is that should production go down the route of radical automation in the course of this century, then equally radical Keynesian demand management will be necessary to maintain demand for goods and services and ensure continuing rises in living standards.

China, India, Brazil and Russia have all implemented Keynesian fiscal stimulus programs, so the demand for German exports in these countries is itself the result of Keynesian economics. The sheer scale of China’s fiscal stimulus is well known: the Chinese budget deficit is projected to be about $154.4 billion in 2010 or about 2.8% of China’s GDP (see “China forecasts $154.4 billion deficit,” 5 March, 2010), and it was China that was the main cause of the strong growth in German exports.

Although demand from the US and the rest of Europe was apparently not strong, even here the American and other EU stimulus packages will have propped up Germany’s export markets, and prevented a much larger fall in Germany’s export revenue.

Is it really remotely credible that if the US, EU, China, India and Brazil had implemented savage austerity that Germany could have achieved such impressive export growth? Not in the least. The idea is nonsensical. It is obvious that the recent record growth in Germany must be explained to a significant extent by Chinese Keynesian stimulus.

Chinese Keynesianism is the factor ignored by the Swedish blogger Stefan Karlsson, who notes (no doubt correctly too) that German government purchases rose only by 0.5% in Q2 2010 (as compared with 6.6% between Q1 2008 and Q1 2010) showing, he thinks, a negative correlation between German government purchasing and GDP growth (see Stefan Karlsson, “Nice Try,” August 28, 2010).

My response is: “Pull the other one, Stefan.” It is rather obvious that, since it was mainly exports driving the rise in German GDP growth in Q2 2010, you should be looking at the purchases of German goods by China that were either directly or indirectly the result of China’s large Keynesian stimulus, as well as (to a lesser extent) the other emerging economies like India, Brazil and Russia, which all had Keynesian stimulus packages as well. (As an aside, it can be noted that Australia also benefited from China's Keynesianism, and, along with its own stimulus package, actually escaped having a recession.)

Various conservatives are attributing the strong German growth in 2010 to German fiscal conservatism, but this idea is so obviously wrong it is laughable.

Let’s review the facts. First, the German response to the global downturn of 2008–2009. In late 2008, the German government implemented an emergency bailout package of €480 billion for German banks. In November 2008, the government then approved a stimulus package of €23 billion ($29 billion). On 27 January 2009, the German cabinet approved a €50 billion (£46.7 billion) stimulus package over two years (at 1.6% of gross domestic product).

Thus recent commentators who are pointing to the strong growth figures for summer 2010 ignore the fact that the German recession actually ended a year ago. The recovery in 2009 was clearly caused by government stimulus (i.e., good old-fashioned Keynesianism). Even in 2010 the German economy is still feeling the effects of the stimulus, and austerity measures will not begin until next year. Merkel’s recent €80 billion austerity programme is spread over 4 years and will commence slowly in 2011 (see Quentin Peel, “Hefty stimuli dent Germany’s ‘Swabian’ habit,” June 21 2010).

Furthermore, one important part of Germany’s state intervention to stabilise the economy was the “Kurzarbeit” (“short work”) program. This was a program of government subsidies to German industries to keep people employed by working shorter hours. The measure has significantly supported aggregate demand, which in turn prevented a large fall in consumption and production. The measure also stopped unemployment from rising significantly. You could not have a more obvious instance of state intervention and distortion of the free market than this program, but it was clearly highly successful.

Moreover, the German government moved quickly to protect its manufacturing sector and other industries from the effects of the financial crisis by setting up a “German Economic Fund” (first with €100 billion and then €115 billion) through the state-owned development bank KfW. This allowed the government to lend money directly to German companies unable to borrow from private markets. As of July 2010, some €13 billion had been borrowed by German companies. This is an obvious example of emergency industrial policy – and a sensible one as well. Britain and the US should have copied the Germans and protected their industries by adopting similar measures.

But there is growing evidence that the recent record growth might be the highpoint for the German recovery. Like Japan, Germany is an export-led growth economy. With the abandonment of Keynesianism and the turn to austerity measures increasing worldwide, it is likely that Germany’s exports will fall, which will cause growth to slow.

To attribute German recovery to austerity is, quite frankly, a sign of ignorance, idiocy, or outright dishonesty. Whether the various conservatives peddling this nonsense are idiots, ignoramuses, or just plain liars is a question I’ll leave for readers to decide.